Managed Funds Industry Flouting the Laws

This morning we refer to the ‘Lazy Researcher’s Handbook’ again – Wikipedia. I’ll tell you why in a moment.

But first a quick lesson.

In business parlance your company is deemed to be insolvent if it’s unable to pay a debt by the due date. And it’s not a laughing matter either.

You can’t just say, “She’ll be right mate, I’m good for it.”

If you can’t pay your debts and you continue to trade, potentially incurring further debts, then you’re trading while insolvent and therefore breaking the law.

That’s when a company can appoint, or be forced to appoint an Administrator. They’ll come in and run the business back into solvency or move towards winding the business up if it’s not sustainable.

There’s not much to argue with there. After all, as a potential creditor you’d want to know if the company you’re supplying goods to is capable of paying the bill.

And for those creditors that are already owed money you wouldn’t want the company incurring more debts which would make it even harder for you to get your money back. You wouldn’t want the ‘debt pool’ getting bigger while the company assets stay the same or get smaller.

So, according to the ‘Lazy Researcher’s Handbook’, there are two types of insolvency:

Cash flow insolvency – Unable to pay debts as they fall due.

Balance sheet insolvency – Having negative net assets – in other words, liabilities exceed assets.

To your muddle-headed editor that seems pretty clear. It may not be to the legal letter of the law, but it’s a plain English definition that’s hard to argue with.

However, it seems there’s a secret clause that’s unknown to the vast majority of the population. Until now…

Well, we have to assume it’s a secret clause, because otherwise the businesses flouting insolvency laws would be in big, big trouble.

The businesses flouting the laws are the managed funds industry. And more specifically those that run mortgage funds.

The sad thing is this isn’t a new story. It’s been trundling along since late last year when global markets started to melt down, and the government introduced the deposit guarantee.

The guarantee on savings accounts made good old cash investments much more attractive compared to unguaranteed mortgage funds. As we wrote at the time, why on earth would you risk getting a 7% return on a mortgage fund when you can get 5.5% on a plain old high interest savings account?

You’d be mad not to switch from one to the other.

Of course, we weren’t the only ones to think that. Those that had actually invested cash in the funds couldn’t get out fast enough.

Or rather they tried to get out. Because one year later, and according to The Age, there is still $15 billion of savings locked up in ‘frozen’ mortgage funds.

The paper claims:

“Investors in AXA Asia Pacific’s mortgage funds have been able to reclaim no more than 22.8 per cent of their holdings in the past year.”

While…

“Australian Unity, a smaller fund, has paid out 55 per cent of the value of redemption requests.”

And…

“Colonial has paid out around 20 per cent of its funds under management, but the wealth giant did not say what proportion of requests it had met.”

But stop complaining ‘old people’, because the newspaper provides the helpful advice that:

“These companies say none of their investors have incurred losses because the capital is intact, albeit unavailable.”

Imagine a creditor saying that to a supplier: “I know I haven’t paid you yet, but you haven’t lost anything have you, because I am going to pay you… eventually!”

That’s a surefire way to ruin your business and your reputation.

Call us crazy, but we’re not quite sure how these funds can get away with it. If we think about it logically, whether investor funds are held on balance sheet or off balance sheet they would be reported as a liability.

In other words, it’s money which the fund owes to someone else – the investor.

On the other side of the balance sheet are the assets. In the case of a mortgage fund the assets are mortgages. It’s an asset because the fund is owed the money from the borrower.

Now, if we look at the definitions again…

Cash flow insolvency – Unable to pay debts as they fall due.

Balance sheet insolvency – Having negative net assets – in other words, liabilities exceed assets.

Only a pedant could claim that mortgage funds aren’t insolvent.

Whichever way you look at it, these mortgage funds are unable to meet their obligations to creditors. For any other business the creditors could demand the appointment of an administrator to manage the repayments from the company.

Of course, the argument is that by allowing the mortgage funds to slowly repay investors over time that’s actually been beneficial to investors as they are getting back more money than if there had been a ‘firesale’ of the funds’ assets.

Naturally that’s nonsense. Sure, investors may have only seen a return of 80 cents or even 70 cents on the dollar, but the argument doesn’t stand up in two ways.

For a start, it ignores the opportunity cost of those funds not being available to invest elsewhere. Maybe the investor could have received 70 cents on the dollar which they may have invested in cash for a while. But maybe they would’ve bought shares ten months ago while the market was still cheap.

Right now they would be sitting on handsome gains.

But even if they didn’t buy shares, surely it’s the right of an investor to ask for their money back.

I mean, as the current product disclosure statement (PDS) for Perpetual explains:

“You can withdraw all or part of your investment in a Fund at any time…”

It goes on to explain there are certain conditions, one of which is the right to be given “up to 70 days” to process the withdrawal request – maybe they’ve got the old pensioners in doing the admin if it takes them that long!

Although it doesn’t say anything about 12 months!

But then the PDS does explain that “In certain emergency situations… we may suspend processing all applications, switches or withdrawals for that fund.”

The emergency being that the fund is actually insolvent.

Not only that, but this whole sorry affair makes a mockery of the idea that Australia doesn’t have a subprime style mortgage disaster waiting to happen.

Think about it. What is a mortgage fund? It’s a fund of mortgages. You don’t need a “Hedonic Calculation” to work that one out.

Considering the robust quality of the Australian lending market – as we’ve been told countless times – you’d think there would be a rush to buy up these mortgages. Wouldn’t institutional investors see an opportunity to buy something up on the cheap?

I mean, this would be easy pickings for a big investor. If they offered to pay say 70 cents or 80 cents on the dollar to a whole bunch of pensioners, the old timers would rip their arms off as they grabbed the cash.

Given a choice between 80 cents today, or possibly nothing or a dollar in twelve months, if I was risk averse I know which I’d choose.

But we all know why institutional investors aren’t doing that. Because while they may be greedy, for the most part, they aren’t completely stupid.

$15 billion is a drop in the ocean compared to the $1 trillion that’s held in superannuation funds in Australia. In fact, that equals just 1.5% of Australia’s total super assets.

But with banks jacking up interest rates faster than their buddies at the Reserve Bank of Australia (RBA), it gives the big gun investors even less reason to own mortgages, and the pensioner even more reason to get out while they can.

Cheers.
Kris.

60-Second Market Round Up
by Shae Smith

It was a quiet trading day for the S&P/ASX200 closing slightly higher to 4,719, up by 17 points. The RBA increase of 25 basis points was expected, so the market didn’t have any nasty surprises.

Australians are now waiting to see if the three other major banks follow suit and almost double the increase for their standard variable mortgage rate, like Westpac did yesterday.

The Dow Jones Industrial Average rallied 126 points to finish at 10,471.58 as the “shopping season” begun. There are some people that also used to call this season Christmas! However, news that the Dow was up 60% since March this year saw traders put their money into riskier securities.

In the UK overnight, the FTSE was up by 2.34% ending that day at 5,312.17.

The Nikkei was up 2.43% closing to 9,572.20. Bank of Japan has announced a new ‘quantitative easing’ program, mostly at the government insistence. Some are saying that the Y10 trillion (AUD$125 billion) won’t boost the economy the way the leaders had hoped.

Spot gold rallied to a record high overnight, finally pushing past the elusive $1,200 mark to USD$1,201.50 an ounce.

The price of gold has gained more than 36% this year. This could be the metals biggest yearly gain since 1979.

The price of spot gold in Australian dollars is trading at $1,292.11, while in US Dollars it is trading at $1,195.72. The price of silver in Aussie dollars is $20.64 and in US Dollars it is $19.09.

The Aussie dollar versus the US dollar is trading at USD$0.9256, and against the Japanese Yen JPY80.23

Crude oil closed at USD$77.89

For the biggest movers on the market yesterday click here…

Tagged as: balance sheet, creditor, debts, insolvency, investor, managed funds, mortgage fund